9th Fed rate cut is likely today

Analysts expect it, and worry about too much stimulus

October 02, 2001|By William Patalon III | William Patalon III,SUN STAFF

Federal Reserve policy-makers will almost certainly cut interest rates for the ninth time this year when they meet today, most economists agree. Whether they should is another matter.

"I'm torn between what the Fed will do, and what the Fed should do," said Richard Yamarone, chief economist for Argus Research Co., in New York.

With the country mired in its first downturn since the 1990-1991 recession, experts are starting to worry that the monetary and fiscal stimulus packages aimed at reviving growth may be too much of a good thing - and could even beckon inflation sometime in 2002.

Since the start of this year, central bank policy-makers have pared the benchmark overnight lending rate by a total of 3.5 percentage points - six half-point cuts and two quarter-point reductions. While economists are nearly unanimous in predicting a rate reduction today, they are split over whether the Fed will announce a quarter-point or half-point reduction after its Federal Open Market Committee meeting.

"More and more, people are thinking half a point," said David Citron, managing director for the local office of Carret and Co., a money-management firm. "There are still some [analysts] that are thinking a quarter-point now and a quarter-point in November [at the next meeting of Fed policy-makers]. But I am predicting half-point now and a half-point in November. The economy is still very, very weak."

Since the start of this year, the overnight lending rate has dropped from 6.5 percent to 3 percent. The overnight lending rate is what Fed-member banks charge one another for overnight loans.

In response, commercial banks have dropped their "prime" lending rate from 9.5 percent to 6 percent.

If the Fed were to cut rates by a half-point now, and again next month, the overnight lending rate would fall to a 40-year low of 2 percent.

The central bank's objective in lowering interest rates is to jump-start spending by both consumers and corporations, since as rates go lower, the easier and cheaper it becomes to borrow.

All the benefits aren't seen immediately, however: It can take six to 18 months for the rate reductions to work their way through the economy and have the desired impact.

It's that lag that experts see as bothersome: A substantial amount of stimulus is about to hit the U.S. economy with a potential tsunami-like force, some economists say.

Since the Sept. 11 terrorist attacks, the Fed has broadened its stimulus strategy. In addition to cutting rates, the central bank has injected tens of billions of dollars into the U.S. economy by buying back Treasury bonds. The cash infusion is expected to more directly benefit consumers and corporations alike.

The Fed isn't acting alone. Before the attacks, the Bush administration pushed through a tax cut that has been putting hundreds of dollars into the hands of many American consumers.

Congress, immediately after the attacks, said it would allocate billions for the fight against terrorism, and for the cleanup and rebuilding of devastated sites. Billions more will go toward a bailout of the U.S. airline industry. And no matter what the initial cost estimates are, most experts say the price tag will only get larger.

All this monetary and fiscal stimulus will hit the economy in the months to come, and economists hope it will spark a robust rebound from a decline that will prove to be deep but short. Argus' Yamarone predicts that the American economy will advance at a 3 percent clip in the first quarter and 4 percent in the second quarter.

If the stimulus works as planned, spending by consumers and businesses will be strong, as will the competition for capital. But those are inflationary forces, which will force the Fed to reverse course and start pushing up rates, some analysts say.

The central bank will then have to walk its typical tightrope: It will need to lift rates enough to fend off inflation, but not so much that it impairs consumer confidence, and short-circuits recovery.

Not everyone sees inflation as a problem, however.

"I'm not terribly concerned about inflationary problems because of the Fed action," said John Hussman, portfolio manager of the Hussman Strategic Growth mutual fund based in Ellicott City. "Inflation is linked more closely to expansions in government spending than with expansions in the money supply. ... It's when you spend money, but there's not a corresponding rise in output, that you get inflation."

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